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David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures. Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions. Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

Book Review: Win by not Losing

Just follow my methods and you will make money. Yes, it is another one of *those* books. Most of them are not worth your money. This one might be worth it, but let me give you my misgivings.

The book warms up slowly, because it spends most of its early time destroying other ideas, without introducing their main ideas. For example, it spends time destroying:

Gains in the market come slowly and steadily. Correct, that’s wrong. As my readers should know, market returns are lumpy. [Note to readers at Amazon, there are links at my blog that explain these concepts in greater detail.]

Modern Portfolio Theory. Again, no argument here, it is not a good explanation as to how the market works.

Volatility isn’t risk; risk is the potential to lose. Again right.

Diversification among risky assets does not provide much risk reduction. Again right.

Most mutual funds miss out on the ability to limit risk, because they forbid market timing. Here I differ. Aside from funds that aim to time the markets, the asset allocation decision is not in the hands of the managers, but the shareholders, who must them selves decide how much stocks to hold.

This leads to their main hypothesis, that people have been duped into buy & hold investing, when they could make a lot more money if they only invested when conditions are favorable.

There are two problems with this: 1) how can you tell when times are favorable or not? I use the credit cycle, and estimates of what various asset classes are likely to return if they were private businesses, but not everyone can follow that. They give their simplified version, which is a moving average crossover method. Buy when stocks are above the moving average. Sell when they are below. Simple, huh?

Yes, simple, and that brings up problem 2. If a lot of people began managing money in a way like this, the market would become more volatile. At moving average crossovers, people would rush to buy and sell as groups. Some would shorten their moving average formula to get a jump on others. Any risk control method, if used by many will cease to work well.

Other Difficulties

Though it is not a major aspect of their book, and it comes toward the end, part of the goal of the book is to interest people in purchasing their newsletter and/or money management services.

At times, buy and hold investing is the optimal way to go for an era. Also, not holding assets for a long time limits the ability to limit taxes, and compound really large gains. My mother and my father-in-law, amateur investors both, limited their taxes on their investing largely through buying and holding quality stocks over decades. (The authors do advise that their strategy is best done in a tax-deferred account.)

At one point the book insists that the Capital Asset Pricing Model [CAPM] implies that the equity risk premium is constant. Sorry, but that’s not true. Many financial planners act as if it is true. What is true is that it is challenging to estimate the varying equity risk premium. Value investors have their own way of doing it, but it boils down to: “I’m not seeing many attractive opportunities to deploy capital.”

On page 116, they make too much out of how households have too much money in cash as a fraction of their assets near market bottoms. The amount of cash may vary some — in general at market bottoms, institutions hold relatively more stock, but the main reason for the increased percentage invested in cash is simply the fall in prices for risky assets. Aside from IPOs, mergers for cash, acquisitions for cash, money doesn’t enter & exit the market. Market prices reflect the willing of marginal buyers and sellers to trade cash for stock, and vice-versa. In aggregate, nothing changes except the price.

They criticize the Facebook IPO as one where sellers knew things would get worse, and so they sold, delivering losses to buyers. But Facebook stock is considerably higher now than the IPO price. Those that took the losses from the IPO didn’t wait long enough.

Page 150 — it took a longer time after 1980 before 401(k)s began replacing Defined Benefit pensions plans in any major way. Congress passed several pieces of legislation in the late 80s which made sponsoring a DB plan less attractive; that’s when the changes started in earnest.

Page 171 — there were many in the insurance industry that remembered being burned on Collateralized Debt Obligations [CDOs] 1998-2002. It was a common insight that CDOs were weak assets, and underpriced among insurers. A new class of buyers got skinned in 2008, particularly banks and hedge funds.

Page 180 — there were many firms that anticipated the fall in subprime lending. I worked for one of them. I wrote an article about it for RealMoney.com in late 2006. It took a lot of courage to take action on the “Big Short,” and not many did.

The book dabbles on many topics, showing a superficial understanding of many ideas/events in order to show they one should not buy & hold. The book plods for 80%+ of its pages developing what fails, and spends less than 20% of its time giving what one ought to do. Their strategy takes up ~40 pages of a ~240 page book.

All that said, is the strategy a reasonable one? Probably yes, but not if a lot of people adopt it. Advanced amateur investors could implement the ideas of the book easily, those with less experience would need help to do it, and the authors offer that help, much of it free, and more for a fee.

Quibbles

Already expressed. I’ll stick with value investing; I’d rather have a lumpy 15% than a smooth 12%. This book could have been better if it focused on its positive strategy, fleshed it out more, so that average amateurs would have had a clearer direction on what to do.

Full disclosure: The publisher sent me the book after asking me if I wanted it.

If you enter Amazon through my site, and you buy anything, I get a small commission. This is my main source of blog revenue. I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip. Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book. Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website. Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites. Whether you buy at Amazon directly or enter via my site, your prices don’t change.

About David Merkel

David J. Merkel, CFA, FSA, is a leading commentator at the excellent investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited David to write for the site, and write he does — on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, and more. His specialty is looking at the interlinkages in the markets in order to understand individual markets better.
David is also presently a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. He also manages the internal profit sharing and charitable endowment monies of the firm.
Prior to joining Hovde in 2003, Merkel managed corporate bonds for Dwight Asset Management. In 1998, he joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.
His background as a life actuary has given David a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that David will deal with in this blog.
Merkel holds bachelor’s and master’s degrees from Johns Hopkins University. In his spare time, he takes care of his eight children with his wonderful wife Ruth. View all posts by David Merkel →